Will higher inflation spoil our economic party?

The South African economy is experiencing one of its longest sustained periods of growth in history. This growth has been underpinned by rampant consumerism and massive government expenditure as the country continues its lengthy journey to transformation.

Individual investors have seldom had it this good. They have benefited from both the rampant stock market and a property market which seemed, till recently, to have no limits. The goodwill generated by this combination of financial excess has in turn led to even more reckless expenditure, as consumers grab whatever luxury goods and services they can get their hands on.

But revelling in this growth has its nasty after effects. In much the same way as too many drinks at a dinner party leave one feeling a trifle green, the inevitable result of too much cash is a nasty economic hangover. We call this hangover inflation and South Africa is caught in its nasty grip right now.

No more Mr. Nice Guy

We are faced with the daunting reality that the sceptre of rising inflation will finally quash our economic party? And we are not the only ones who are wrestling with this reality. Reserve Bank governor, Tito Mboweni, at a dinner party in Pretoria recently, was quoted as saying: "Maybe we [the Reserve Bank] have been far too nice to our people, and interest rates have been too low."

Read between the lines and you will find that the person who administers hangover cures to the economy in the form of interest rate hikes is about to get tough. And if Mboweni gets tough, we had better brace ourselves for significant central bank action in the coming months.

Effective use of interest rate hikes will not cause the economy to grind to a total halt. Instead they should alleviate inflationary pressure by assisting the economy in slowing down slightly. To use an analogy, consider a speeding freight train. If the train continues unabated, it will certainly derail. An interest rate hike is a bit like pulling the emergency brake on this speeding freight train. At first, the effect is hardly noticeable. But as the brakes bite the train slowly bleeds speed and is able to negotiate the track ahead at a more sensible pace.

Zimbabwe's 'hit-it-with-a-big-stick' approach will never work

Inflation is a natural occurrence in an economy. As long as it is properly managed it should never reach nightmarish proportions as it has in our northern neighbour Zimbabwe. In this country, the price of basic goods increases so quickly that stores are now forced to hike prices as often as three times a day. A colleague in the media recently joked that golfers would order their meals and drinks at tee-off time because that was the only way to avoid the price increases which would occur while they completed their round.

When inflation hits unmanageable levels the economy loses the power to fight its effects. At this stage, there are no quick and painless cures for the Zimbabwean economy. Despite this, the Zimbabwean government is desperate to do something to keep the country functioning.

One such attempt was to implement immediate and draconian price controls. Store owners were ordered by government decree to lower the prices of essential goods with immediate effect. This practice barely worked in 'wealthy'communist countries in the past and has already had unwelcome consequences in Zimbabwe today. Without government subsidies, stores simply stop selling those goods they cannot market profitably. And this means the Zimbabwean consumer will once again stare at shelves void of basic goods and other essentials.

Perhaps in a desperate measure to divert attention from their economic problems, the Zimbabwean government is now attempting to force public companies to hand ownership back to Zimbabweans. This move will further damage the economy and delay any hopes of much needed direct foreign investment.

Thanks for small mercies

Returning to South Africa we have reason to be grateful for the prudent economic policies implemented by National Treasury and supported by the central bank in the last decade. While the inflation beast is not yet tamed we are certainly better off than almost every other country in Africa.

South Africa will continue to fight inflation and strive to keep inflation within the 3% to 6% range in the long term. This will help us to reach a similar position to the more stable Western countries. To quote Mboweni: "Switzerland shows that with low inflation and prudent policies one can achieve full employment - this is what the Swiss have. If you have low inflation and credible policies you can have low interest rates as a result."

Editor's thoughts:
Interest rate hikes afford the best option where inflation busting is concerned. Central bankers can either do nothing, risking rampant inflation and an imploding economy; or they can take action to curb inflation with interest rate hikes, to gradually apply the brakes. Have the recent interest rates forced you to take a fresh look at your finances? Send your comments to gareth@fanews.co.za